Wednesday, December 16, 2015

Berkshire Hathaway (BRK-A/B): Update post-Q3/2015 results (released 11/06/2015)

Berkshire Hathaway (BRK-A/B)
Notes following Q3/2015 Earnings
11/06/2015

Restatement of acquisition strategy:
1.       Sensible price
2.       Consistent earnings power
3.       Good returns-on-equity (ROE)
4.       Honest management

Acquisitions (recent)

Van Tuyl Group (“Berkshire Hathaway Automotive”) – Q1/2015
  • 81 dealerships in 10 states
  •  Includes 2 related insurance businesses + 2 auto auctions + one manufacturer of auto. fluid maintenance
  •  $6.6 billion in assets / $2.5 billion in liabilities = $4.112 billion net assets ($2.39 billion net tangible assets)
  • Goodwill of $1.719 billion expected to be amortizable for tax purposes

My Notes on "Van Tuyl":

Rationale: US SAAR remains strong and the average life of a vehicle on the road is 11.5 years (Link), there are economies of scale in owning dealerships, the "Van Tuyl" Group is a collection of independently owned dealerships (thus is decentralized, similar to BRK), and....the capital base of Berkshire Hathaway can accelerate growth and consolidation in the auto dealership space. Common returns on equity in auto dealerships are >20%. 
  • Locations (see map)
  • Dealerships do not have “Van Tuyl” or “Berkshire Hathaway” name, rather a collection of dealerships across U.S.
  • Over $9 billion in revenue (had $5.3 billion in revenue in 2008)
  • All dealerships are independently operated (model is built on general managers having minority equity ownership in dealership or working to get equity stake)
  • Two insurance underwriters: Old United Casualty Co. & Old United Life
  • CEO is Jeff Rachor, a former Sonic Automotive Inc. president. Launched a venture in 2008 with Michael Dell’s investment firm which allowed Rachor the ability to purchase upto $500m of “premier” auto dealerships (http://www.autonews.com/article/20100118/RETAIL07/100119835/rachor-to-join-retailer-van-tuyl-steer-expansion)
  • My belief is Berkshire/ Warren Buffett looks only for businesses where if the business had “unlimited capital” it could grow faster (ample reinvestment runway) and scale (improved operations, margins). The Berkshire Hathaway capital base and cash flow provides WEB opportunity to inject more capital than the business could obtain prior to the acquisition
  • The top 5 public auto dealerships: CarMax (KMX), AutoNation (AN), Copart (CPRT), Penske Automotive (PAG), and Lithia Motors (LAD) all have ROE >20%, low net profit margins of ~2-4% (except CPRT), similar gross margins of 14-15%.
  • Article on dealership economy of scale: http://mibiz.com/item/21965-deals-for-wheels-auto-dealers-leverage-economies-of-scale-to-expand-footprints-through-acquisitions
Berkshire Hathaway Automotive auto dealership locations - 81 in U.S. (12/2015)

AltaLink, L.P. (will merge into Utilities & Energy segment) – 12/1/2014

  • Alberta’s largest regulated electricity transmission company, owns and operates ~60% of transmission system in Alberta
  • Supplies 85% of Alberta with electricity
  • Purchased for C$3.1 billion ($2.73 billion USD)

My notes on AltaLink LP:

Rationale: Company provides a necessary product (electricity), will earn decent returns on investment as guaranteed by regulatory body in Canada (~8.30% ROE), limited competition (supplies Alberta with 85% of electricity), and Berkshire Hathaway capital base can reinvest large sums of money and earn a "known" solid ROE. 
  •  Quick facts on AltaLink: http://www.altalink.ca/news/quick-facts.cfm
  • ~$200m annual run-rate of net income + ~$240m run-rate Depreciation & Amortization
  • Capital expenditures far exceed cash flow
  • Annualized EBITDA  = $560m on ~$800m revenue for 2015
  • Capital Expenditures mostly funded through increased debt (LT + commercial paper), less so capital injection and Cash Flow
  • Estimate of $7.4 billion total invested capital ($6.9 billion tangible), earnings ~ 5-6% ROIC using current year run rate D&A as actual maintenance capital expenditures
  • Similar to “Van Tuyl”, Berkshire Hathaway likely invested in AltaLink LP as they could utilize the Berkshire Hathaway capital base for large amount of reinvestments that would not have been capable under stand-alone AltaLink (almost no cash on balance sheet, ~$600m EBITDA and 7.2x net debt-to-EBITDA)
  •  Due to regulatory environment, AltaLink applies to have certain “return on equity” qualities based on their estimated operating expenses, and thus attempt to get certain pricing characteristics from customers in order to obtain their stated ROE.

"Approved" Returns on Equity for AltaLink, LP = 8.30%

Notes from Credit Rating Agency DBRS: “regulations approved ROE is lowest for investor-owned utilities in Canada over the past 10 years.”

Other investments:

  •  Purchased General Electrics (GE) tank cars from their leasing unit for $1.0 billion on September 30, 2015


Balance Sheet notes:

Fixed Maturity Investments:
  • Little movement YTD
  • 44% are invested in foreign governments
  • Of that, 75% are in Germany, Australia, Canada, The Netherlands
Investments (Securities)
  • Cost basis increased YTD from $58.4 billion to $63.0 billion
  •  Fair value decline YTD from $117.5 billion to $110.3 billion
  • 58% of the investments are in 4 companies: American Express (AXP), International Business Machines (IBM), Wells-Fargo (WFC), and Coca-Cola (KO)
  • Unrealized gains on securities has declined from $60.1 billion to $50.2 billion, largely from ~$5.7 billion decline in “The big 4”
  • Of the $110.3 billion fair value of investments, 96% are allocated to the “insurance” balance sheets
  •  International Business Machine (IBM) is down $2 billion (15% of cost)
Investment Activity (other)

  • Exchanged Philips 66 (PSX) shares for Philips Specialty Products (now Lubrizol Specialty Products) for $2.1 billion – (2/25/2014)
  • Exchanged Graham Holdings (GHC) for WPLG – (6/30/2014)
  • Took a $678m impairment on Tesco PLC


Insurance Operations:

GEICO:

  •  Continue to implement premium rate increases where necessary
  • Strong premium written (11.4%) and premiums earned (11.2%)
  • Increases in premiums reflect growth in in voluntary auto policies-in-force (6.1%) and higher premiums per policy
  • YTD = policies-in-force grew by 662,000 policies

Berkshire Hathaway Reinsurance Group
P&C:
  • Premium increases due to new 10-year, 20% quota-share contract with Insurance Australia Group Ltd (IAG), effective July 1, 2015
  • Offset by premium decline in property catastrophe, quota-share, London businesses
  • Premium volume constrained because the rates currently are generally inadequate
  • As dollar strengthens, it adds FX gains because estimate liabilities get revalued lower in dollar-terms
Retroactive Reinsurance:
  • Contract with Liberty Mutual in 2014 for $3 billion did not repeat in 2015



Railroad, Utilities & Energy:

BNSF:
Capital investments in:
  • Line expansion
  • System improvements projects
  • Additional equipment

Other items:
  • New employee hires
  • Favorable winter weather conditions

 Revenue:
  • Down 3% ytd
  • 5% decline in average revenue per car/unit
  • Partially offset by a 1% increase in volumes
  • Decrease in average revenue per car/unit in 2015 due to 50% decline in fuel surcharges ($1.1 billion) due to lower fuel prices, offset partially by increases in average rates
  • Impact of lower fuel surcharge revenues affected revenues of all product lines
  • Freight revenues (industrial) down 13% in Q3/15 to $1.4 billion – lower volumes due to lower crude prices on petroleum products and frac sands, lower steel volume, lower revenue per car/unit
  • Freight revenues (agricultural) up 4% to $1.0 billion – higher domestic grain shipments, driving volume up 11%, offset by lower revenue per car/unit
  • Freight revenues (Coal) down 6% to $1.2 billion, mostly due to lower revenue per car/unit. Coal volumes increased 5% y/y
  • Freight revenues (consumer) down 3% to $1.7 billion, mostly due to lower revenue per car/unit, offset by volume increases of 5%

 Expenses:
  • Compensation & benefits: down, due to reduced overtime, lower training costs, offset by higher employment levels and wage rates



Utilities and Energy (Berkshire Hathaway Energy Group)
  • 89.9% owned
  • Domestic regulated utility interests – PacifiCorp, MidAmerican, NV Energy
  • Great Britain two regulated electricity distribution businesses – Northern Powergrid

 PacifiCorp:
  • Electric utility in Utah, Oregon, and Wyoming
  • Revenue down 1% y/y due to lower renewable energy credit revenue and lower rates and volumes
  • Energy costs decline more than revenues, thus margin improved

 MidAmerican Energy Company: ("MEC")
  • Electric and natural gas utility in Iowa and Illinois
  • Revenue impacted by lower average per unit cost of gas sold, offset by lower cost of sales
  • Higher rates in Iowa

 NV Energy:
  • Electric and gas utility in Nevada
  • Higher average regulated rates



Manufacturing, Service and Retailing:

McLane:
  • Wholesale distribution business that provides grocery and non-food products to retailers, convenience stores, and restaurants
  • Distilled spirits, wine and beer
  • Marked by high sales volume and very low profit margins
  • Several significant customers – Wal-Mart (WMT), 7-Eleven, and Yum!Brands (YUM)

 Manufacturing:
  • Industrial and end-user products group includes: Lubrizol, ISCAR, Forest River, CTB
  • Building products: Acme, Benjamin Moore, Johns Manville, Shaw, MiTek
  • Apparel: Fruit of the Loom, Russell, Vanity Fair

 Industrial:
  • Revenue declines due to strong dollar, which impacted by $210m of the $324m decline
  • Commodity cost deflation in petroleum and metals used in certain products resulted in lower selling prices, especially Lubrizol, ISCAR, and certain sectors in Marmon
  • Lower oil prices and competitive pressures, experienced lower selling prices

Building Products:
  •  Lower average raw material and energy costs helped, offset somewhat by FX translation and increased restructuring charges
  • Shaw (flooring) and insulation and roofing (Johns Manville) helped increase earnings the most

  
Other notes:

  • Debt issued by BNSF or Berkshire Hathaway Energy – not guaranteed by Berkshire Hathaway, and not committed to provide capital to support BHE or BNSF or any subsidiaries


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